Brexit Sounds Alarm for Europe-Tied Structured Notes in Korea

Notes tied to Europe’s benchmark equity index have become South Korea’s most popular structured securities just as the U.K.’s vote to leave the European Union batters shares.

Sales of Korean notes tied to the Euro Stoxx 50 Index reached 8.5 trillion won ($7.5 billion) from January through June, the most among products that bet on major equity gauges at home and abroad. Issuance linked to the European benchmark made up 37 percent of all share-tied securities, up from 32 percent in the same period last year in a market that vies with Japan to be the largest in Asia.

The high portion of notes tied to the Euro Stoxx 50 gauge is increasing concern that investors will suffer losses if other countries follow Britain’s lead and leave the 28-member bloc, causing a stock market crash, according to Samsung Securities Co. The index fell 8.6 percent the day after the vote and is down about 18 percent from a year ago.

“Some market participants are concerned about the concentration of products tied to the European benchmark,” said Gyun Jun, the head of research at Samsung Securities in Seoul. A “balloon effect” has inflated the popularity of the European equity-linked products as volatility is higher than other indexes, he said.

High Volatility

Volatility on the Euro Stoxx 50 averaged 26 this year compared with 18 for the U.S. Vix. Investors typically get a coupon plus their principal upon maturity provided the linked security stays above a protective barrier. Below that, they stand to lose a portion of their capital.

Overall June sales of equity-linked securities were also affected by Brexit, dropping 12 percent to 3.2 trillion won from 3.6 trillion won in May, the lowest level in four months, according to data from Korea Securities Depository. The outstanding balance of structured notes was 97.6 trillion won last November, according to the latest data from the Korea Financial Services Commission.

During June issuance was low because of “clients being nervous” about falling markets, according to Yeonchoo Kim, the head of trading at Korea Investment & Securities Co. “We are concerned that Brexit isn’t a short-term story –- it will affect markets again and again.”

The FSC said it has “no specific concern” about Euro Stoxx-tied products as the index is recovering from the sharp fall after Brexit and it’s monitoring markets in case of further European equity declines, according to an e-mailed statement.

Korean regulators warned last year about the big portion of equity-linked notes tied to the China Enterprise Index. There are signs investors have been diversifying since then. Products linked to the Hang Seng Index reached 1.22 trillion won in the last three months and notes tied to the German DAX and Taiwan’s benchmark index were 7 billion won and 4 billion won, respectively, the first ever “meaningful” volumes, Jun said.